What can governments and the private sector do to prepare for an economic downturn?

April 2017 | EXPERT BRIEFING | ECONOMIC TRENDS

financierworldwide.com

2017 is set to be a distinctive year on a number of fronts. All businesses are operating against the backdrop of an uncertain and challenging global economic environment. Not since the 1930s has such a combination of falling growth, increasing pessimism and the looming spectre of economic protectionism cast such a pall on the global outlook.

The US presidential election victory of Donald Trump brought some temporary cheer to global markets on the back of promises of a huge fiscal stimulus, combined with regulatory roll-backs. With many countries having relied heavily on monetary easing by central bankers to support growth, it is unsurprising that markets have cheered these developments with gusto. Tax cuts and infrastructure spending are expected to reflate the US economy, which, in turn, will hopefully do the same for the rest of the global economy. However, this alone may not be enough to counter the downward draft being generated by the stalling Chinese economy and lack of consumer demand in the world’s developed markets. Taken together with the darkening spectre of anti-globalisation sentiment that appears to ominously be gaining currency in certain parts of the developed world, there is certainly cause for concern that the current economic uncertainty could be a protracted one.

In Singapore, for example, despite a better than expected full-year growth figure of 2 percent for 2016, headwinds are expected to persist and remain challenging for the economy in the near term.

Financing stimulus through taxation

Economies need to finance fiscal stimulus in some way, the chief method being an increase in taxation. And therein lies the predicament. In many countries, high household debt and a struggling corporate sector, already burdened with low profitability and weak balance sheets, are likely to complicate any efforts to impose tax increases. In an environment where countries potentially have to resort to higher taxation to fund their fiscal programmes, businesses may start feeling the pinch if tax authorities start to extract more than their usual pound of flesh. So what can governments and the private sector collectively do to ensure that businesses, particularly small and medium enterprises (SMEs), survive an economic crunch?

Shift toward indirect taxes

In recent decades there has been a shift in emphasis toward indirect taxation, which taxes at the point of consumption, rather than on income or profits. Governments can benefit from this approach and achieve their revenue targets by levying tax on a significantly broader tax base, at the same time as maintaining a competitive corporate tax rate crucial for promoting business activity and attracting overseas investment. For these reasons, the move toward indirect taxation is becoming more common around the world, with many countries either enacting tax reforms to introduce it or increasing applicable rates within their existing indirect tax regimes.

For example, Malaysia adopted a Goods and Services Tax regime in 2015, while Japan has announced a 2 percent increase in its consumption tax rate which is set to take effect from 2019.

Such moves to increase consumption taxes have often gone hand in hand with a steady reduction in the headline corporate tax rates. Malaysia, for instance, had a headline corporate tax rate as high as 27 percent almost a decade ago, but following the introduction of a GST regime in 2015, the headline corporate tax rate is now 3 percentage points lower. Likewise, Thailand, which cut its corporate tax rate progressively by almost 10 percentage points from a rate as high as 30 percent to its current rate of 20 percent, is contemplating a 1 percentage point hike in its VAT rate to 8 percent.

Ultimately, this can only be a good thing, given the fact that capital ultimately needs to be allocated toward its most efficient use and investors always look at net returns on an after-tax basis when making decisions about where to invest.

From the standpoint of businesses, indirect taxation technically has a minimal effect on their bottom line given that the burden of the tax is designed to be passed on to the end consumer. For this specific reason, though, one needs to be mindful of the fact that indirect taxation is often regressive in its nature, with poor and low income households tending to be hit more disproportionately by its effects. If it is not levied appropriately at the right levels, it risks dampening consumer demand and can potentially have the deleterious effect of slowing down the economy.

Tax incentives

Tax incentives can help stimulate economic activity and play an important role in encouraging companies to maintain their business operations in their host country and survive major economic downturns.

In Singapore, tax incentives such as the headquarters programme and the global trader programme grant attractive concessionary rates of corporate taxation to companies that meet certain prescribed qualifying criteria. More importantly, the ecosystem of such incentives also includes a broad suite of grants and measures, such as the Productivity and Innovation Credit scheme, which is embedded in the corporate tax system.

The wide array of incentives have been very successful in attracting foreign direct investment into Singapore over the years, as evidenced by the range of globally renowned companies which have established their regional headquarters in Singapore. Despite its own small consumer base that would not be sufficient in itself to entice the entry of these huge multinationals, Singapore has instead managed to position these incentives to attract management and headquarter type activities, in order to facilitate these companies’ access to the Southeast Asian (and indeed in some cases, the even broader Asian) hinterland.

Different types of activities have benefited in different ways from these incentives. The financial services sector, for instance, which is a beneficiary of a slew of tax incentives and which has helped cement Singapore’s status as a global financial hub, contributes approximately 11 percent of the country’s GDP and accounts for more than 25 percent of total corporate taxes paid. Such figures underscore the important role that incentives play within key sectors of the Singapore economy.

Companies, particularly SMEs, should take full advantage of such measures to cushion the negative impact of any downturn and to perhaps even leverage such measures to help them grow, scale-up or internationalise to capitalise on any retreat by their competitors.

Fiscal stimulus

Countries facing the prospect of slow growth and trade constraints in a potentially more protectionist environment could take a leaf out of the US’ playbook and go down the same fiscal stimulus route. Economic downturns tend to be self-fulfilling in that any collapse in demand reverberates through various channels, resulting in further contractions which, ultimately, create a downward spiral.

To stave off the pernicious effects of an uncontrolled collapse in demand, governments can step in as a ‘spender of last resort’ to prevent such a collapse in demand. Often this could be the shot in the arm that an economy needs and a boon to businesses, especially the SME sector, which is often the hardest hit segment of the economy.

Singapore takes a holistic approach

In February, Singapore released its Committee for the Future Economy (CFE) report – the country’s fourth economic restructuring paper in three decades. It is a bold effort aimed at encouraging a rethink of the country’s primary economic drivers going forward. The report essentially outlines seven wide-ranging, mutually reinforcing strategies to help grow the economy by an average of 2 to 3 percent per year.

These strategies include an effort to deepen international connections entailing more trade liberalisation and the establishment of a global innovation alliance aimed at stimulating more collaborative innovation at an industry level. The report encourages the acquisition of deeper skillsets at the worker level, which will emulate the success of countries like Germany in maintaining a high level of skills training at every stage of the delivery of a product or service. It emphasises the need for local enterprises to achieve a certain critical scale in order to compete effectively in international markets. Smaller firms are encouraged to embrace digital capabilities and to leverage them effectively in their businesses.

The report reserves a role for Singapore as a city to lead the way in creating a globally connected live, work and play hub that is at the forefront of trends and opportunities. Finally, industries are encouraged to cross-synergise each other in positively reinforcing ways, along with the creation of an economic ecosystem where various players can partner each other in more collaborative ways, including the government doing its part to review and reshape the tax system and to create a more sustainable environment for the long-term survival of businesses.

While businesses await the return of blue skies over their economies, it is worth pondering some of these measures to see if they can provide some respite from the perils of a protracted downturn if such a prognosis bears out.

Edwin Leow is a tax director and Ruben Siva is a tax associate director at Nexia TS Tax Services Pte Ltd, a member of Nexia International. Mr Leow can be contacted on +65 6534 5700 or by email: edwinleow@nexiats.com.sg. Mr Siva can be contacted on +65 6534 5700 or by email:rubensiva@nexiats.com.sg.